Over the years, some financial statement users have complained that the old accounting definition of a business was overly broad and captured too many day-to-day purchases of assets. The broad scope caused many transactions to be subject to the relatively complex rules for business combinations under U.S. Generally Accepted Accounting Principles (GAAP). To help remedy these shortcomings, the Financial Accounting Standards Board (FASB) launched a three-stage project.
First, in January, the FASB published Accounting Standards Update (ASU) No. 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business, to clear up whether the purchase of an asset (or group of assets) qualifies as the sale or disposal of a business. Accounting for business combinations is generally considered more cumbersome than accounting for a straight-up acquisition of an asset.
The update provides a shortcut to help accountants make a quick call about when a set of assets isn’t a business: The set is not a business when substantially all the fair value of the gross assets acquired (or disposed of) is concentrated in a single asset or a group of similar identifiable assets.
ASU 2017-01 also establishes new requirements for a set of assets to be considered a business. A set of assets must, at minimum, include:
- An input (such as people, intellectual property and raw materials), and
- A substantive process.
Together, the acquired inputs and process should significantly contribute to create outputs. The buyer’s ability to replace missing inputs or processes with its own is no longer enough to meet the updated definition of a business.
Although outputs aren’t required for an asset set to be a business, outputs generally are a key element of a business. Outputs typically are considered goods or services for customers that provide (or have the ability to provide) a return to investors in the form of dividends, lower costs or other economic benefits.
In February, the FASB completed its second stage of the business vs. asset acquisition project: ASU 2017-05, Other Income — Gains and Losses from the Derecognition of Nonfinancial Assets (Subtopic 610-20): Clarifying the Scope of Asset Derecognition Guidance and Accounting for Partial Sales of Nonfinancial Assets. This updated standard helps businesses clarify how to account for sales and disposals of nonfinancial assets like real estate.
Work in progress
Now, the FASB is ready to embark on stage three, which aims to clear up the overlapping guidance in certain areas of accounting for acquisitions of assets and businesses. Specifically, the FASB has agreed to research whether some of the guidance in Accounting Standards Codification Subtopic 805-50, Acquisition of Assets Rather than a Business, and Topic 805, Business Combinations, could be aligned.
The FASB’s research will focus on the following three areas of the accounting guidance that differ significantly for assets vs. business combinations:
- Transaction costs (which are expensed in a business combination and capitalized in an asset acquisition),
- In-process research and development (which is capitalized in a business combination but generally expensed in an asset acquisition), and
- Contingent consideration (which is recognized at fair value on the acquisition date in a business combination but is generally recognized when resolved in an asset acquisition).
Reducing the differences between the two sets of guidance could help decrease the incentives for businesses to structure deals to avoid complex accounting rules.
FASB member Marc Siegel cautioned that delving into accounting for transaction costs may be a large undertaking. In addition, any changes to U.S. GAAP’s business combinations guidance could make the FASB’s accounting differ from international accounting guidance.
International Financial Reporting Standard (IFRS) 3, Business Combinations, was issued in 2008, shortly after the FASB published Statement of Financial Accounting Standards (SFAS) No. 141(r), Business Combinations. Since then, the accounting boards have referred to these standards as a rare success story for international convergence and have resisted efforts to amend them in ways that would undermine the converged accounting.
The updated definition of a business, which goes into effect for public companies in 2018 and private ones in 2019, will result in more transactions being treated as asset acquisitions, rather than business combinations. This will have significant implications from an accounting perspective.
Contact us if you’re considering an acquisition. We can help evaluate whether your transaction meets the new definition of a business and, if so, help you comply with the updated accounting guidance.
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